How to Protect Your 401(k) From the Failing Dollar

by Hunkar Ozyasar

Many investors worry that the U.S. dollar will lose substantial value.

The U.S. economy is operating a so-called double deficit. The tax receipts are insufficient to fully cover government spending, while the imbalance between imports and exports causes a trade deficit. Both factors can result in significant depreciation of the U.S. dollar, which can manifest itself in the form high domestic inflation, which raises prices of goods and services and weakens the dollar against foreign currencies. Depending on your future plans, you may have to take precautions to deal with one of these scenarios.

Conservative Domestic Strategy

If you anticipate spending all or nearly all of your retirement savings within the United States, your primary concern is the domestic inflation. If prices of such things as gas, utilities, automobiles or the vacation home you wish to buy rise far faster than you can grow the funds in your 401(k), you may be unable to afford the lifestyle you desire. A conservative and practically fail-safe way of protecting against domestic inflation is to include Treasury Inflation-Protected Securities also known as TIPS in your 401(k). The higher the inflation rate, the more these securities return and essentially protect your savings against domestic price increases. However, TIPS will help you to slightly outpace inflation. If you need to grow your funds far faster than the inflation rate to achieve the lifestyle you desire, you need a more aggressive growth strategy.

Aggressive Domestic Strategy

If your current savings will not be sufficient to retire comfortably, even if they grow at a slightly higher rate than inflation, you need to either select a riskier path and include stocks and bonds in your 401(k) that can potentially advance far faster than inflation. The former approach involves significant risks and your already insufficient funds may shrink further as a result of adverse moves in the stock market. If, however, you wish to take this risk, stocks of American corporations that sell a great deal of their products or services in foreign markets can be worth including in your portfolio. Such firms benefit from vibrant foreign economies.

Conservative International Strategy

If you anticipate spending most or all of your retirement funds in a country outside of the United States, the inflation rate in the U.S. is of little concern to you. Exchange rate variations, however, pose a major risk as your dollars maybe worth far fewer Euros, British Pounds or Mexican Pesos. If your primary objective is to prevent such an erosion of your U.S. dollar-denominated funds against the currency you will eventually convert your savings into, include government bonds issued in the target currency in your 401k. Usually, the best way to do so is to purchase one or several bond funds that heavily weight government bonds in the target currency. While government bonds usually involve low risk, the governments in some countries are operating under heavy debt and do carry some risk of default. You should therefore carefully assess this probability carefully beforehand.

Aggressive International Strategy

If you will spend your retirement funds in a different currency and must grow them far faster than the rate of inflation in that country, you need to include stocks that promise a rapid rate of growth, traded in foreign exchanges and denominated in the target currency. Like the equivalent strategy involving dollar-denominated stocks, this approach involves significant risks and you should carefully weight whether scaling your financial goals back is a better approach. If you decide to include foreign stocks, an international stock fund is usually your best bet.

References

About the Author

Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.